4 Inflating The Bubble

The days when a bank issued a mortgage and held onto it for the life of that loan ended long ago. Mortgages had become huge profit-generators for investment banks, which bought the loans from other banks and non-bank lenders, packaged them together, sliced them up, and sold them as securities. In theory, as long as homeowners paid their mortgages, these securitized loan investments, also known as structured products, were relatively safe. But, theory and practice were two very different things

Investors Take A Gamble They Believe Is Safe

Narvik, Norway

How Narvik, Norway, a small town near the Arctic circle, was fooled into investing in Collateralized Debt Obligations (CDOs). From CNBC's "House of Cards," original air date, February 12, 2009.

Investors from Wall Street to Warsaw bought the securities with little or no knowledge they contained pieces of toxic loans made to high-risk borrowers--- loans that could default on homes that could go into foreclosure.

AIG Builds Risky Insurance Business

And, just in case something did go wrong with those securities, some investors bought insurance policies called Credit Default Swaps, issued by companies such as AIG. A CDS guaranteed an investor would not lose money, even on the riskiest asset, assuring a payment even if the underlying security defaulted. And by 2005, with expectations that home values would continue rising and homeowners would continue making their mortgage payments, AIG believed the CDS business was fail-safe.

International Appetite Grows For Mortgage Securities

Crap Into AAA

Former Moody's analyst Ann Rutledge explains how ratings agencies turned "crap into Triple A" by assigning the highest investment grade to risky collateralized debt obligations. From CNBC's "House of Cards," original air date, February 12, 2009.

As demand by consumers for mortgages continued to grow, so did demand by institutional investors for mortgage-backed securities. The most common form: Collateralized Debt Obligations, known as CDOs. Flush with billions, hedge funds and sovereign wealth funds gobbled up these CDOs. But the AAA credit ratings that helped lure investors were deceiving. They masked the underlying risk of those securitized subprime mortgages. One former Moody's analyst says it was easy to "turn crap into Triple A."

Reward Turns Into Risk

Rating Agencies

The role of Moody's, Standard and Poor's, and Fitch in judging the risks of mortgage-backed securities and grading their investment quality. From CNBC's "House of Cards," original air date, February 12, 2009.

Fannie And Freddie Join The Party

Prior to the downgrade and the cloud that eventually hung over subprime securities, even Fannie Mae and Freddie Mac, once known for buying the safest kind of mortgages, got into the game. Following an accounting scandal that temporarily slowed down their mortgage-buying business between 2003-2005, Fannie and Freddie felt compelled to compete with Wall Street for a share of all those subprime loans being sold by their originators. So Fannie and Freddie lowered their standards, just as the lenders had done. They began buying lesser-quality mortgages, including subprime loans, exactly the kind they avoided years earlier.